- Rising interest rates are a negative for real estate.
- Gold and oil are still dropping.
- Company earnings are not beating expectations.
So, where do we begin?
The economy has been firing on all eight cylinders for several years now. So long, in fact, that many do not or cannot accept the fact that all good things must come to an end. Since the 2008 recession, the only negative that has remained constant is the continuing dilemma of the “underemployed”.
Let me digress for a while and delve into the real issues I see as storm clouds on the horizon. Below are the top five storms I see brewing:
- Real estate
- Subprime auto loans
- Falling commodity prices
- Stalling equity markets and corporate earnings
- Unpaid student loan debt
1. Real Estate
Just this past week there was an article detailing data from the National Association of Realtors (NAR), disclosing that existing home sales dropped 10.5% on an annual basis to 3.76 million units. This was the sharpest decline in over five years. The blame for the drop was tied to new required regulations for home buyers. What is perplexing about this excuse is NAR economist Lawrence Yun’s comments. The article cited Yun as saying that:
“most of November’s decline was likely due to regulations that came into effect in October aimed at simplifying paperwork for home purchasing. Yun said it appeared lenders and closing companies were being cautious about using the new mandated paperwork.”
Here is what I do not understand. How can simplifying paperwork make lenders “more cautious about using… the new mandated paperwork”?
Also noted was the fact that median home prices increased 6.3% in November to $220,300. This comes as interest rates are on the cusp of finally rising, thus putting pressure (albeit minor) on monthly mortgage rate payments. This has the very real possibility of pricing out investors whose eligibility for financing was borderline to begin with.
2. Subprime auto loans
Casey Research has a terrific article that sums up the problems in the subprime auto market. I strongly suggest that you read the article. Just a few of the highlights of the article are the following points:
- The value of U.S. car loans now tops $1 trillion for the first time ever. This means the car loan market is 47% larger than all U.S. credit card debt combined.
- According to the Federal Reserve Bank of New York, lenders have approved 96.7% of car loan applicants this year. In 2013, they only approved 89.7% of loan applicants.
- It’s also never been cheaper to borrow. In 2007, the average rate for an auto loan was 7.8%. Today, it’s only 4.1%.
- For combined Q2 2015 and Q3 2015, 64% of all new auto loans were classified as subprime.
- The average loan term for a new car loan is 67 months. For a used car, the average loan term is 62 months. Both are records.
The only logical conclusion that can be derived is that the finances of the average American are still so weak that they will do anything/everything to get a car. Regardless of the rate, or risks associated with it.
3. Falling commodity prices
Remember $100 crude oil prices? Or $1,700 gold prices? Or $100 ton iron ore prices? They are all distant faded memories. Currently, oil is $36 a barrel, gold is $1,070 an ounce, and iron ore is $42 a ton. Commodity stocks from Cliffs Natural Resources (NYSE:CLF) to Peabody Energy (NYSE:BTU) (both of which I have written articles about) are struggling to pay off debt and keep their operations running due to the declines in commodity prices. Just this past week, Cliffs announced that it sold its coal operations to streamline its business and strengthen its balance sheet while waiting for the iron ore business to stabilize and or strengthen. Similarly, oil producers and metals mining/exploration companies are either going out of business or curtailing their operations at an ever increasing pace.
For 2016, Citi’s predictions commodity by commodity can be found here. Its outlook calls for 30% plus returns from natural gas and oil. Where are these predictions coming from? The backdrop of huge 2015 losses obviously produced a low base from which to begin 2016, but the overwhelming consensus is for oil and natural gas to be stable during 2016. This is clearly a case of Citi sticking its neck out with a prediction that will garnish plenty of attention. Give it credit for not sticking with the herd mentality on this one.
4. Stalling equity markets and corporate earnings
Historically, the equities markets have produced stellar returns. According to an article from geeksonfinace.com, the average return in equities markets from 1926 to 2010 was 9.8%. For 2015, the markets are struggling to erase negative returns. Interestingly, the Barron’s round table consensus group predicted a nearly 10% rise in equity prices in 2015 (which obviously did not materialize) and also repeated that bullish prediction for 2016 by anticipating an 8% return in the S&P. So what happened in 2015? Corporate earnings were not as robust as expected. Commodity prices put pressure on margins of commodity producing companies. Furthermore, there are headwinds from external market forces that are also weighing on the equities markets. As referenced by this article which appeared on Business Insider, equities markets are on the precipice of doing something they have not done since 1939: see negative returns during a pre-election year. Per the article, on average, the DJIA gains 10.4% during pre-election years. With less than one week to go in 2015, the DJIA is currently negative by 1.5%
5. Unpaid student loan debt
Once again, we have stumbled upon an excellent Bloomberg article discussing unpaid student loan debt. The main takeaway from the article is the fact that “about 3 million parents have $71 billion in loans, contributing to more than $1.2 trillion in federal education debt. As of May 2014, half of the balance was in deferment, racking up interest at annual rates as high as 7.9 percent.” The rate was as low as 1.8 percent just four years ago. It is key to note that this is debt that parents have taken out for the education of their children and does not include loans for their own college education.
The Institute for College Access & Success released a detailed 36 page analysis of what the class of 2014 faces regarding student debt. Some highlights:
- 69% of college seniors who graduated from public and private non-profit colleges in 2014 had student loan debt.
- Average debt at graduation rose 56 percent, from $18,550 to $28,950, more than double the rate of inflation (25%) over this 10-year period.
So, what does this all mean?
To look at any one or two of the above categories and see their potential to stymie the economy, one would be smart to be cautious. To look at all five, one needs to contemplate the very real possibility of these creating the beginnings of another downturn in the economy. I strongly suggest a cautious and conservative investment outlook for 2016. While the risk one takes should always be based on your own risk tolerance levels, they should also be balanced by the very real possibility of a slowing economy which may also include deflation. Best of health and trading to all in 2016!